- The Central Bank of Iceland raises its policy rate - Monetary policy statement

The Board of Governors of the Central Bank of Iceland has decided to raise the
policy rate by 1.25 percentage points to 15%. The assumptions underlying the
inflation forecast published in Monetary Bulletin in November 2007 entailing an
unchanged policy rate until after the middle of this year have not held. 

Inflation has been higher than forecast and inflation expectations have risen.
Demand has also been stronger than was expected. The exchange rate of the króna
has depreciated more than entailed in an alternative scenario published in
Monetary Bulletin in November. It assumed that such a development would be met
with a higher policy rate. The real exchange rate of the króna is now very near
a long term historical low which it reached in November 2001. If this
development is not reversed a period of persistent inflation would be ahead
with spiralling increases in prices, wages and the price of foreign exchange.
The depreciation of the króna in recent weeks also undermines the balance sheet
of indebted households and businesses and thus financial stability looking
further ahead. It is therefore crucial that the depreciation of the króna is
reversed as quickly as possible. 

Deteriorating financial conditions in global markets imply that it has become
more difficult to finance the current account deficit. Adjustment of the
national economy with a contraction of demand will thus not be avoided. It will
only be more painful if inflation is allowed to get out of hand. Consequently,
it will be necessary to continue to pursue a very tight monetary policy in
order to bring inflation and inflation expectations under control and increase
confidence in the króna. 

On Thursday April 10, the Central Bank of Iceland will issue its Monetary
Bulletin with new macroeconomic and inflation forecasts. At the same time the
Board of Governors will announce its next decision on interest rates.